Activision Blizzard Worth $15 On Strong Franchises, Online Turnaround

Activision Blizzard’s (NASDAQ:ATVI) stock has climbed 10% over the course of the last month driven by strong earnings and the successful release of the highly anticipated "Call of Duty: Black Ops II" video game. We believe that the company has potential for future growth, particularly following the release of next generation consoles from both Microsoft (NASDAQ:MSFT) and Sony. Our $15 price estimate for Activision Blizzard’s stock implies a premium of 25% to the current market price.

Going Against The Trend

The video game industry has had a tough year with both the X-Box 360 and Playstation 3 in the waning phase of their product cycles. Industry sales fell by 28% year-over-year in the first half of the year and by 19% in the third quarter [Video Games sales in U.S. October 2012, NPD Group, 9th November, 2012 ]. Despite this, Activision reported a 12% increase in net revenues in the third quarter of 2012, helped by the huge success of Diablo III, which was the top-selling game in North America and Europe during the quarter and the Skylanders franchise. Console game revenues, however, fell nearly 20% in the first half of 2012.

With the timely release of the latest in the popular Call of Duty series and the onset of the holiday season, we expect an improvement in console game sales in the fourth quarter.

Wii U Sets The Stage

The recently released Nintendo Wii U sold more than 400,000 consoles in first week of its launch. The launch also boosted the sales of its predecessor; the original Wii sold 300,000 units in the same week [How the video games industry is faring, Businessweek,3rd December, 2012]. Activision earns just 15% of its console game revenues from Nintendo, and we expect a much bigger impact from the Playstation 4 and X-box 720, which are expected to be released in the next two years. Success will be dependent on Activision’s ability to continue to deliver on innovative video games and maintain its highly popular franchises like Call of Duty and Diablo.

Skylanders

The Skylanders franchise has proven to be a massive success, generating life-to-date revenues of more than $500 million as of the end of the third quarter. Apart from earning revenues through unit sales, the company also manufactures and sells physical models of the franchise’s characters. These models have to be bought separately and placed on the “The Portal of Power” for the user to access the character. The innovative business model led to a massive increase in PC and other revenues from $251 million in the first nine months of 2011 to $727 million in the first nine months of 2012. The company continues to cash in on the franchise and has recently released a new title, "Skylanders Lost Islands." We expect Activision to sustain low double digit revenue growth for the next two to three years for this franchise. However, video game popularity does fade as the World of Warcraft franchise has proven, and we expect revenues to decline long-term.

Online Subscriptions

Regarding the World of Warcraft franchise, Activision appears to have finally bucked the trend of declining online subscribers. The latest edition, Mists of Pandaria, sold 2.7 million copies in the first week of release and pushed the number of subscribers from 9.1 million in August, to over 10 million at the end of September. The franchise reached a peak of nearly 12 million in 2010 but then saw a downtrend as more competition entered the market. Despite the success of Mists of Pandaria, we expect the slide to continue, albeit at a slower than earlier anticipated rate. There are also rumors in the market of a new massively multiplayer online game being developed by Activision, Titan, and we have factored this into our forecast with a long-term increase in subscribers.

We also expect a decline in average revenue per subscriber earned by Activision, influenced by increased competition in the domain.

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